winding down for the year

For professional equity investors the final two weeks of the calendar year are perhaps the only time when they can truly rest. Two reasons:

–virtually every professional is evaluated and compensated on performance over periods–usually one year, sometimes one and three, sometimes one, three and five or other longer time frames–that conclude on December 31st. As a result, by mid-December one’s personal financial fate is pretty well sealed. Even those who are very close to thresholds where pay can go way up or way down may elect to remain on the sidelines with fingers crossed. That’s because the short-term direction of prices is notoriously hard to predict–in fact, academic research argues that fluctuations over, say, a week or two are purely random. This means yearend tweaks are just as likely to backfire as they are to make performance better.

This is the only time of the year when professionals feel completely safe in taking their hands off the tiller and resting. It would be crazy not to take the opportunity. Trading volume for the S&P 500 yesterday was about 20% below average, for example, marketing, I think, the start of the yearend lull.

–accountants for asset managers like the books to close neatly. They don’t want to have trades that have been agreed to in December not settle before yearend, instead hanging over into the following year. Although every stock exchange has rules about how many days after being agreed to trades are supposed to settle, not all do.

As a result, most asset management companies “request” that their portfolio managers not enter into new bargains during, say, the last two weeks of the year. Adminstrators take a huge risk if they order PMs to take their hands off the money: PMs have a fiduciary obligation to do what’s best for their clients, not what’s best for the accounting department. And there are those poor few who are hoping to rescue their year through a flash of Christmas brilliance. Still, everyone understands what they’re being asked to do. And almost everyone jumps at the chance to comply.

Advice for you and me: watch prices anyway. Sometimes weird price fluctuations happen during the last couple of trading days of the year. The fact that almost every professional is away from work can cause last-minute buy or sell orders have an unusually large impact on prices. This can be a great chance to take the other side of the trade, since most of us don’t really care that our trade will settle in the first week of January.